HFSC Hearing on the CHOICE Act

“A Legislative Proposal to Create Hope and Opportunity for Investors, Consumers, and Entrepreneurs”

Wednesday, April 26, 2017

Key Topics & Takeaways

Volcker Rule: Rep. French Hill (R-Ark.) asked if the Volcker Rule was “misdirected.” Wallison described the rule as a “serious problem” for all banks, their affiliates, and subsidiaries. Wallison also said that the Volcker Rule inhibited legitimate hedging strategies and has made banks of all sizes more risk averse.

Transparency: Rep. Ann Wagner (R-Mo.) asked if Congress should require a “sane” level of disclosures and transparency when it comes to decisions made at the Financial Stability Board (FSB) like they would with other international economic and trade negotiations. Pollock replied that transparency is a “very important part” of the CHOICE Act, as the FSB should not tell the U.S. what to do.

SIFI Designation: Rep. Tom Emmer (R-Minn.) asked the panel if FSOC’s SIFI designation process was fair to regulated firms. Wallison argued it is not, pointing out that one firm was prevented from viewing FSOC’s designation decision documents. Wallison described FSOC as a “star chamber” due to its lack of transparency, and also criticized FSOC’s structure, saying that bank regulators had too many votes relative to other regulators.

Dr. Lisa D. Cook, Associate Professor, Economics and International Relations, Michigan State University

Hester Peirce, Director, Financial Markets Working Group and Senior Research Fellow, Mercatus Center, George Mason University

John Allison, Former President and Chief Executive Officer, Cato Institute

Opening Statements

In his opening statement, Chairman Jeb Hensarling (R-Texas) said that since the Dodd-Frank Act was passed, the economy has been “sucked in the slowest, weakest recovery,” and that the bill has been a bigger burden to enterprise than “all other Obama-era regulations combined.” He explained that the Financial CHOICE Act (“CHOICE Act”) will end bailouts with bankruptcy, replace complexity with simplicity, and gave a summary of other provisions of the bill. Hensarling continued that the CHOICE Act releases financial institutions from burdensome regulations in exchange for simple capital requirements, adding that banks will plan for their expansions instead of their failures. He concluded by explaining how the CHOICE Act repeals the government’s ability to make systemically important financial institution (SIFI) designations, remove previously made non-bank SIFI designations, and will also repeal the “misguided, complex, and unneeded” Volcker Rule.

In her opening statement, Ranking Member Maxine Waters (D-N.Y.) referred to the bill as “dead on arrival,” and named it the “Wrong CHOICE Act.” She defended the Consumer Protection Financial Bureau (CFPB) and praised the Dodd-Frank Act. Waters opined that even though Wall Street reform has made banks safer, banks want to return to fewer protections. She stressed that the bill “must not become law.”

Rep. Daniel Kildee (D-Mich.) criticized the CHOICE Act for ending the “most important aspects” of Wall Street reform. He continued that while he would support improving some parts of the Dodd-Frank Act, the CHOICE Act would go “back to the days where Wall Street practices crippled the economy.”

Rep. Brad Sherman (D-Calif.) stressed that the CHOICE Act does not have bipartisan support and requested for Hensarling to break up the bill due to its many parts, adding the need for a better trade policy.

Testimony

Peter J. Wallison, Senior Fellow and Arthur F. Burn Fellow, Financial Policy Studies, American Enterprise InstituteIn his testimony, Wallison stated that the Dodd-Frank Act was responsible for the historically slow recovery since the financial crisis, that it was “completely unnecessary,” and was the most restrictive financial regulatory law since the 1930s. He continued that Congress did not know the true cause of the crisis, resulting in “unnecessary restrictions” in the Dodd-Frank Act. Those restrictions include: 1) Costly regulations on community banks, inhibiting the growth of small businesses; 2) Creating the Financial Stability Oversight Council (FSOC) and giving them the power to designate firms as SIFIs; 3) Creating the “unnecessary” orderly liquidation authority (OLA); 4) Giving the Federal Reserve the authority to finance failing clearing houses; and 5) Creating the Volcker Rule, which has the potential to create another financial crisis.

Dr. Norbert J. Michel, Senior Research Fellow, Financial Regulations and Monetary Policy, The Heritage FoundationIn his testimony, Michel opined that the Dodd-Frank Act “pointlessly” addressed issued that had “nothing to do” with the financial crisis, and that it made the “too big to fail” problem worse. He lauded the CHOICE Act for its improvements to the bankruptcy process and how it “greatly improves” oversight of the CFPB, as it is currently unaccountable to the public. He then addressed the Durbin amendment in the Dodd-Frank Act, which requires the Fed to implement price controls on retailers for processing debit cards, arguing that the amendment should be repealed due anti-trust laws.

The Honorable Michael S. Barr, Professor of Law, University of Michigan Law SchoolIn his testimony, Barr criticized the CHOICE Act because it would expose taxpayers, businesses and the economy to “fresh” risks of financial abuse and collapse. He listed three “serious flaws” in the legislation: 1) Weakening oversight of the financial system; 2) Eliminating the OLA; and 3) Undermining customer and investor protections. Barr explained that the legislation eliminates the ability of the Fed to supervise non-bank SIFIs, abolishes the Office of Financial Research (OFR), and allows for shadow banks to get a “free pass,” leading to weakened oversight of the biggest banks. He continued that the bill “foolishly” relies on bankruptcy alone, and outlined that the OLA has three features that are not found in bankruptcy: 1) Part of the ongoing system of supervision; 2) the Federal Deposit Insurance Corporation (FDIC) can provide liquidity; and 3) the FDIC can coordinate globally.

Alex J. Pollock, Distinguished Senior Fellow, The R Street InstituteIn his testimony, focused on the accountability, capital, and congressional governance of the administrative state. He explained that accountability is the central concept to every part of the government, and that all agencies in the government must be accountable to elected officials. He lauded the bill for requiring the Fed to conduct regulatory reviews, as well as forcing all financial regulatory agencies to fall under the congressional appropriations process. Pollock continued that more capital for less intrusive regulations is a “rational tradeoff,” and that the 10 percent leverage ratio is a “fair and workable level.”

Dr. Lisa D. Cook, Associate Professor, Economics and International Relations, Michigan State UniversityIn her testimony, Cook gave a summary of the financial crisis and stressed that the cause was irresponsible financial practices. She continued that the Dodd-Frank Act was a legislative response that was intended to reassure taxpayers and let regulators and financial institutions know that this problem would “never happen again.” Cook explained that community and consumer loans have grown consistently since 2012, and that the economy has expanded each quarter since 2011. She stressed that practices that led to the financial crisis should never occur again, that there should be thoughtful financial reform, and that many provisions of the CHOICE Act should be rejected.

Hester Peirce, Director, Financial Markets Working Group and Senior Research Fellow, Mercatus Center, George Mason UniversityIn her testimony, Peirce argued that it “makes sense” to look at the financial system periodically to see how it is regulated and ensure it is working correctly. She stated that the CHOICE Act makes a number of improvements that will make the financial system work better, including changes to a number of rules, ensuring there is a notice and comment period for regulations, requiring financial regulators to complete economic analysis, and providing that Congress has a final look at rules to ensure they should go into effect. Peirce discussed the elimination of Title VIII of the Dodd-Frank Act, adding that making the Federal Reserve the “backstop” for clearing houses creates “terrible incentives,” and that eliminating the backstop will force regulators and market participants to focus on risk management, recovery, and resolution.

John Allison, Former President and Chief Executive Officer, Cato InstituteIn his testimony, Allison explained that government policy is what caused the financial crisis, including housing policy, as well as the monetary and regulatory policy of the Federal Reserve. Regarding monetary policy, he said that the Fed created negative real interest rates, in addition to bubbles in housing, commodities and the stock market. Allison spoke about how the Dodd-Frank Act is causing consolidation and destroying banks, decreasing competition, hurting small business, and slowing economic growth. He criticized regulators for overreacting with the Dodd-Frank Act, as they do not have a “magic wand,” and that capital is a far better protector of risk, as it puts “real skin in the game.”

Question & Answer

Volcker Rule

Rep. Nydia Velazquez (D-N.Y.) asked about the CHOICE Act’s provision that would repeal the Volcker Rule, and whether institutions with federally insured deposits should be allowed to place proprietary bets and invest in hedge funds and private equity funds. Several other Democratic Representatives asked related questions. Barr argued that those institutions should not be allowed to engage in that kind of trading, though he qualified that clarification of the rule, as well as better definitions of market making and proprietary trading, could make the rule more effective.

Rep. French Hill (R-Ark.) asked if the Volcker Rule was “misdirected.” Wallison described the rule as a “serious problem” for all banks, their affiliates, and subsidiaries. Wallison also said that the Volcker Rule inhibited legitimate hedging strategies and has made banks of all sizes more risk averse.

Rep. Ann Wagner (R-Mo.) asked if Congress should require a “sane” level of disclosures and transparency when it comes to decisions made at the Financial Stability Board (FSB) like they would with other international economic and trade negotiations. Pollock replied that transparency is a “very important part” of the CHOICE Act, as the FSB should not tell the U.S. what to do.

SIFI DesignationHensarling asked if the SIFI designation process improved economic stability. Wallison argued that it both made the system less stable, and allowed SIFIs to take more risk due to market perception that they will not fail.

Rep. Bruce Poliquin (R-Maine) asked if FSOC should be allowed to designate asset managers as non-bank SIFIs. Several panelists argued that FSOC should not be able to make that designation, and that there are no asset managers that are systemically important.

Rep. Tom Emmer (R-Minn.) asked the panel if FSOC’s SIFI designation process was fair to regulated firms. Wallison argued it is not, pointing out that one firm was prevented from viewing FSOC’s designation decision documents. Wallison described FSOC as a “star chamber” due to its lack of transparency, and also criticized FSOC’s structure, saying that bank regulators had too many votes relative to other regulators.

Emmer then asked if the panel supported bringing FSOC under the appropriations process, and Peirce said that it would improve transparency.

Wagner discussed the Executive Order that halts the FSOC’s ability to designate non-bank SIFIs while reviewing the designation process, to which Pollock replied that the designation process is inconsistent, political, and judgmental, and that the CHOICE Act would fix this.

Wagner asked if FSOC should have the authority to make designations, to which Pollock and Wallison agreed they should not, and that it would be better to move in the direction of the CHOICE Act.

Rep. Dennis Ross (R-Fla.) noted his support for the bill, and questioned why FSOC should be able to regulate insurance companies rather than the state system of insurance regulation. Wallison explained that the state system of insurance regulation has been very successful over time, and that there is no reason to change that. He continued that FSOC has been implementing decisions made by the FSB, essentially “rubber stamping” what they did.

Resolution Authority

Hensarling asked about the CHOICE Act’s repeal of Title II of the Dodd-Frank Act, which created the OLA. Hensarling asked if OLA – which allows the FDIC to supply liquidity to struggling financial institutions – constitutes a bailout. Michel agreed that it does.

Rep. Carolyn Maloney (D-N.Y.) defended OLA in her questions, noting that non-bankruptcy resolution of SIFIs had bipartisan support at the time of the Dodd-Frank Act’s passage in 2010. Maloney also noted that the FDIC already has the authority to resolve commercial banks, so creating a similar provision for non-bank SIFIs is not an unnatural extension of the FDIC resolution power. Maloney argued that the CHOICE Act would make future bailouts more likely.

Sherman said he supported retaining OLA, and vocalized support for a proposal to break up any company whose size surpassed a 2 percent of gross domestic product (GDP) threshold.

Rep. Keith Rothfus (R-N.Y.) described living wills as a “gateway” for regulators to impose mandatory changes on businesses. Rothfus argued that regulators could restructure companies at will by rejecting living wills and subsequently demanding changes to business operations. Wallison said that regulatory oversight of living wills raised fundamental questions about the free market, and that Fed and FDIC oversight of living wills had no comparison elsewhere in the economy.

Poliquin asked if bankruptcy would be better than a non-bankruptcy resolution process for handling failing SIFIs. Allison agreed, though he qualified this by arguing that SIFI bankruptcy would require certain changes from traditional bankruptcy.

Regulatory Off-Ramp

Hensarling asked Allison about the CHOICE Act’s 10 percent leverage ratio and the accompanying regulatory “off-ramp,” and if this ratio would improve financial stability and regulatory efficiency. Allison supported the ratio, saying that regulators’ attempts to risk-weight assets created market distortions that a flat leverage ratio would avoid.

Rep. Blaine Luetkemeyer (R-Mo.) asked Allison if the 10 percent leverage ratio and off-ramp would encourage economic growth, to which Allison agreed, saying that it would grant banks broader discretion to grant loans.

Sherman asked Barr if the 10 percent leverage ratio could be manipulated by banks, who hypothetically could set aside 10 percent of their capital (in the form of insured deposits) and use their remaining capital to speculate. Barr agreed that relying on a universal 10 percent leverage ratio would not account for the risk profiles of different financial institutions.

Hill described the 10 percent leverage ratio as one of the most “innovative” ideas within the CHOICE Act, and asked if it would effectively preserve financial system stability, to which Allison reiterated his support for the measure. Allison also argued that it would give regulated firms a real choice between compliance regimes.

Capital Formation

Rep. Bill Huizenga (R-Mich.) expressed concern about the declining amount of public companies and the low incidence of public offerings. Peirce argued that the goals of improved capital formation and investor protection are not mutually exclusive, and stressed the importance of allowing individual investors to share in the success of young and growing companies.

Hill also expressed concern about trends in U.S. public capital markets, and argued that the regulations governing proxy advisors and corporate governance of public companies are outdated. Hill asked the panel specifically about the $2,000 threshold of stock ownership for the submission of shareholder proposals, and if that threshold should be revisited. Peirce said it was “reasonable to reexamine” the threshold, as proposals from shareholders can be time consuming.

Rep. Lee Zeldin (R-N.Y.) asked panelists to list the provisions in the CHOICE Act that would help small and mid-sized business grow. Peirce said there are several notable CHOICE Act provisions that would accomplish this, namely the provisions that broaden the definition of accredited investor and streamline venture capital and angel investing rules, which would better allow businesses to access private capital. Allison also argued that by tailoring bank regulations for community banks, Congress can encourage capital formation, as community banks are a critical source of capital for small businesses.

Regulatory Reform

Huizenga asked panelists if certain Securities and Exchange Commission (SEC) regulations that are tangential to investor protection, such as the conflict minerals rule and the Chief Executive Officer (CEO) pay ratio rule, support the SEC’s tripartite mission. Peirce argued these rules do not increase investor protection and are outside the SEC’s field of expertise.

Rep. Scott Tipton (D-Colo.) noted the CHOICE Act’s requirements that regulators conduct cost-benefit analysis on new regulations, and asked the panel if the Dodd-Frank Act required anything similar. Pollock said that Dodd-Frank did not impose any such requirement on regulators, and argued that cost-benefit analysis is an important part of the CHOICE Act.

Rep. Warren Davidson (R-Ohio) asked about due process during SEC administrative proceedings, and if defendants in those proceedings had due process protections equivalent to regular courts. Peirce argued that they did not.

Stress Testing

Rep. Barry Loudermilk (R-Ga.) asked panelists if they believe the stress test process lacked transparency. Allison argued that the process did, and that implementation of Dodd-Frank’s stress testing requirements has led to problems. Specifically, by applying the same (or similar) stress tests to all banks, Allison argued that regulators may be encouraging the industry-wide adoption of poor behaviors. Allison also argued that the qualitative portion of stress tests should be eliminated for all firms. Pollock agreed, saying the qualitative portion is “political and subjective.”

Fiduciary Rule

Ross stated his support for the provision in the CHOICE Act that repeals the Department of Labor’s fiduciary rule.

Democratic ConcernsRep. David Scott (D-Ga.) stated his concern with the capital requirements in the bill.

Several Democratic Members of Congress requested additional hearings on the CHOICE Act, explaining that there were “hundreds” of hearings on the Dodd-Frank Act.

Rep. Stephen Lynch (D-Mass.) noted his concern with the bill, adding that it is the “worst bill” he has seen during his time in Congress. Barr replied that repealing the Volcker Rule would make it “much harder” to manage and supervise firms, to which Cook agreed.

Community Banks

Waters asked why the bill includes antitrust provisions that would speed mergers for all banks that met the 10 percent leverage ratio regardless of size if the CHOICE Act is indeed aimed at providing community banks with relief from the Dodd-Frank Act’s mandates. Barr replied that the CHOICE Act is explicitly not a community bank bill because of the antitrust (and other) provisions.

In a follow-up statement, Waters argued that the antitrust provisions could harm community banks and ordinary Americans, if consolidation led to SIFIs merging with one another.

Rep. Steve Pearce (R-N.M.) asked about the importance of providing regulatory relief to community banks, and Allison replied that most Dodd-Frank Act regulations apply to all financial institutions and disproportionately harm community banks. Several other Representatives asked the panel related questions about the importance of providing community bank relief in any bank reform package. Many panelists argued in favor of providing regulatory compliance relief to small banks.

Rep. Ed Royce (R-Calif.) asked about the regulatory weight placed on community banks due to the Dodd-Frank Act. Allison replied that there is “no question” it makes it more difficult for borrowers to get loans.

Rep. Robert Pittenger (R-N.C.) asked about the impact on small businesses and community banks because of the Dodd-Frank Act. Allison replied that community banks spur entrepreneurial activity, and that there will be much more consolidation in the banking industry if the regulatory burdens are not fixed.

Fannie Mae and Freddie Mac

Rep. Keith Ellison (D-Minn.) questioned the role of Fannie Mae and Freddie Mac in the financial crisis, and asked why they are not a central focus of the CHOICE Act if they were the cause. Cook replied that a report from 2012 concluded that they did not have a role in the crisis. Barr retorted that he is surprised they are not part of any approach in the bill.Shareholder ProposalsRep. Randy Hultgren (R-Ill.) discussed Section 844 of the CHOICE Act which covers shareholder proposals, and asked what concerns there are. Peirce replied that revisiting resubmission thresholds is a way to ensure investors are not paying for companies to respond each year.

Proprietary TradingHultgren noted the lack of clarity between proprietary trading, market making and hedging, to which Wallison agreed and stated that a line cannot be drawn effectively between them, as they look very much alike.CFPB Rep. David Kustoff (R-Tenn.) asked how the CFPB can ensure the validity of claims before they are submitted and made public. Michel replied that the CFPB should confirm the claims internally before posting them publicly, as there is no benefit to the public in posting raw data.

Luetkemeyer criticized the CFPB’s enforcement practices, and noted that the Bureau has never defined its standard for “abusive practices.” Michel pointed out that CFPB Director Richard Cordray has argued against the CFPB having any definition of that standard.

Loudermilk asked the panel if the CFPB’s data collection practices should concern Congress. Michel argued that they should, claiming that CFPB consumer complaint data is too selective and too small (in absolute terms) to responsibly drive policy. Michel noted that CFPB abusive lending enforcement actions have been based on a relatively small absolute total of consumer complaints regarding short-term lenders.

Independent Regulatory AgenciesRep. Claudia Tenney (R-N.Y.) asked if there is a way to put “restraints” on regulators. Michel replied that independent regulatory agencies are a problem, as they should be accountable to the people who are elected.Clearing HousesRep. Trey Hollingsworth (R-Ind.) commented on Title VII of the Dodd-Frank Act and asked how it may change the way clearing houses are structured. Michel replied that mandating the clearing of derivatives is a “very bad idea,” as it will concentrate all the risk into the clearing houses, which will then have a direct line to the Federal Reserve.

Rep. Gwen Moore (D-Wisc.) asked about the impact of the CHOICE Act on the regulatory oversight of clearing houses, given that the bill repeals Title I of the Dodd-Frank Act. Barr said that Congress would need to pass new legislation to ensure stability in clearing houses, and require heightened liquidity standards for clearing houses to prevent market failure.

Durbin Amendment

Rep. Ted Budd (R-N.C.) asked whether the Durbin amendment is helping Americans, to which Michel replied that it is “failing like price controls always do.” Allison added that it has been particularly bad for low income consumers.